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World Wide Losses are the Best Losses
From the frozen lands of Norway's Arctic Circle to the hot sands of the Middle East and the booming metropolis of Shanghai the losses from America's subprime crisis are popping up around the world like angry whac-a-moles. The losses are large and appear larger by being found in the most unexpected of places. Today the focus is on these world-wide losses but I think future historians will focus on how the crisis demonstrated to everyone the power of integrated capital markets to diversify risk.
The losses, of course, are regrettable and the desire to find and apportion blame for the crisis among investors, home buyers, mortgage brokers, credit analysts and regulators is understandable. We should and will learn lessons. And yet, despite problems with transparency one of those lessons ought to be that the crisis would have been worse if the losses had been more concentrated.
From this perspective, world-wide losses are perhaps the best losses of all.
Posted by Alex Tabarrok on April 7, 2008 at 07:45 AM in Economics | Permalink
Comments
Perhaps the alternative way of looking at this is that globalization allows Wall Street to sell to a larger number of rubes. Without that internationalization, perhaps leveraging couldn't have been so ridiculous, and perhaps losses would have been much smaller. And smaller losses might well be better.
Posted by: Mike Huben at Apr 7, 2008 7:54:48 AM
You have not access to the counterfactual world to make so strong and bold a claim (what are you keeping from us other than better posts?)
Posted by: Quinn Mallory at Apr 7, 2008 8:06:27 AM
I can only agree.
Posted by: Personal Finance Management at Apr 7, 2008 8:16:46 AM
Mike nailed it.
And also of course "acceptable debt levels" went crazy for a while. It's been my hobby horse that all levels of society, from the individual to the federal government took on too much.
Now, I think, entire societies must de-leverage.
Posted by: odograph at Apr 7, 2008 8:28:38 AM
...or maybe it was just all those stupid unwashed masses getting newly wealthy due to their increased access to capital and some of them overextending themselves. We should just disallow everyone unintelligent access to the market, so they can't make mistakes/stupid decisions, eh?
Posted by: shawn at Apr 7, 2008 8:36:11 AM
I take some issue with the word "losses" in these type situations.
Certainly, there are some losses. But, if asset prices overshoot intrinsic value, then overcorrect on the downside and then attain sanity levels and you never sold, did you really sustain losses?
If you had to sell because you were leveraged was it a "loss" or did you miss out on undeserved gain?
Are we are talking accounting losses due to write downs of asset prices that were innaccurate to begin with?
Posted by: Andrew at Apr 7, 2008 8:48:57 AM
You are only "newly wealthy" if your net worth climbs. What we've had too often in this country, is "newly indebted."
The savings rate and home equity ratios show this pretty clearly.
Posted by: odograph at Apr 7, 2008 8:54:49 AM
If there are gains then of course integrated capital markets are good. If there are loses they are still good. They can't be bad no matter what the result.
Posted by: sort_of_knowledgable at Apr 7, 2008 9:26:34 AM
Andrew, if people ( in the Middle East, Norway or Bear Stearns) bought subprime loans for more than they were worth, how is that not a loss for them?
I suppose in the short term world-wide distributed losses are indeed good from an American point of view, since they basically mean the rest of the world has paid for American houses. Why the rest of the world should consider this a good thing is beyond me.
Posted by: greatzamfir at Apr 7, 2008 9:54:29 AM
Of course,the crisis would have been worse if the losses had been more concentrated.
But as long as you are doing counterfactuals, if the loans had been more concentrated would the lenders been so careless about the quality of the loans?
So maybe the correct counterfactual is that having the loans more concentrated would have prevented the crises.
Posted by: spencer at Apr 7, 2008 10:08:33 AM
Unfortunately, the message that the world is getting is that investing in America will produce losses. It's not just subprime: thanks to exchange rates, the S&P 500 has fallen more than 50% from its peak earlier this decade when measured in euros rather than dollars. And yet the US still has a voracious need for foreign capital, to the tune of two billion dollars a day. Brad Setser's careful work has demonstrated that nearly all of this is now coming from foreign central banks rather than from private investors. You are being much too sanguine about the possibility of all this ending rather badly.
Posted by: at Apr 7, 2008 11:22:47 AM
if people [..] bought subprime loans for more than they were worth, how is that not a loss for them?
Of course, and those who they bought them from made a profit. When the market price of anything overshoots and corrects, there must have been somebody who bought it at the top, and someone else who sold it to them.
Posted by: improbable at Apr 7, 2008 11:26:42 AM
Well, if they bought at the top and the prices were really high, and they don't recover to those highs before they have to sell, then yes, that is a loss for them, but a gain for the other side.
They mispriced the asset. When you play that game, you just might lose.
But, I don't think those are the kinds of losses we need policy to address.
I think a sustained net loss is what we should be concerned about, not just transient losses or zero sum losses.
Posted by: Andrew at Apr 7, 2008 12:56:22 PM
Greatzamfir is reluctantly partly optimistic ("I suppose in the short term world-wide distributed losses are indeed good from an American point of view, since they basically mean the rest of the world has paid for American houses.")
But if Americans tended to buy houses they couldn't afford, they lost too.
Posted by: zbicyclist at Apr 7, 2008 2:44:24 PM
But what other kinds of losses are there?
One kind I can see is that, in many areas, houses have been built that are much too big (i.e. expensive) for the population, because they could (for a while) find buyers. This is a real loss, resources have been poured into the ground, and will not be recovered. But I don't see any policy which could address this.
Rather the policies are trying to address the risk of recession, and all the bad things that go with that. Even if every individual in a collapsing pyramid scheme is getting what he had coming, if the scheme is big enough it'll hurt the rest of us, and this is what policies might try to avoid.
Posted by: improbable at Apr 7, 2008 2:52:27 PM
*cough*spin*cough*
just like housing wasn't a bubble...
Posted by: archer at Apr 7, 2008 3:42:49 PM
What would be better was if America paid for its own mistakes, instead of the rest of the world having to suffer the rotten fruits of American Capitalist greed...
Posted by: Anne Arckist at Apr 7, 2008 4:47:54 PM
Ordinary investors don't buy the kinds of assets that lost money. It was mostly Wall Street types investing other people's money. That puts a different spin on buyer beware: were Bear Stearn's stockholders to blame for their losses? Could they have seen this coming based on reading annual reports, or does it take insider information?
Most companies know far more about their financial condition than is publicly disclosed. Blaming all losses on the investor makes as much sense as blaming someone buying an airline ticket for not inspecting the plane. There is such a thing as trust and it's possible to betray it.
Posted by: Brian Slesinsky at Apr 8, 2008 2:04:03 AM
Mike, odograph and Spencer are right. It's hard to imagine that we would be in the same situation if lenders weren't able to spread the risk so widely - the ability to mitigate the immediate risk may have spread the losses, but it also enabled them.
Posted by: bcw210 at Apr 8, 2008 2:30:31 AM
I wouldn't let the investors off lightly. Blame America all they want but let them look in the mirror for the real source of the problem.
Posted by: Lord at Apr 8, 2008 3:00:30 AM
caveat emptor,
Anne, the world in general, and UBS shareholders, has had extrodinary returns on "American capitalist Greed", some losses every now and then are part of the lesson. World Capitalist Greed is developing it's stride, with a little wobble here and there.
Posted by: nyongesa at Apr 9, 2008 7:27:36 PM
The general form of Mike's point is that policies which enable private gains and socialized costs may be disastrous. Examples: FDIC, FSLIC, Fed Bailouts, tax incentives for homeowners, federal crop insurance, farm subsidies, ....
I wonder how much of the "subprime" meltdown is actually a result of subprimes and therefore a result of earlier easy money Fed policies (if one can believe Greenspan), tax incentives, and real estate bubbles. Sure, they are claiming that as the cause, but now "subprime meltdown" has replaced "global warming" and "gay marriage" as the excuse du jour. Many seem to have shut off their critical faculties and accepted the excuse on its face. Where is the skepticism that seems to be reserved only for, say, claims that the DDT ban is preventing malaria containment, or that EPA claims about chlorinated water supplies led to the Peruvian cholera outbreak in the early 90s?
Posted by: Eric H at Apr 11, 2008 9:24:33 AM
